2017 has not been kind to
GE. The share price is down 43%
year-to-date, and there are more financial analysts betting on further weakness
than on a rebound.
As we explained in a previous
post, GE long benefitted from strong earnings from its financial business, one
that was built on leverage, itself backed by the AAA credit rating of the
industrial parent.
Blaming Jack Welch, the former
CEO and architect of this strategy, is easy but to a degree unfair: the real problem with the financial business was
not so much the leverage as the excessive reliance on short-term funding.
Fast forward to 2017. The financial business is largely gone,
except for the financing of airplanes and jet engines. But the bureaucratic bloat has soared while
the manic focus on performance and efficiency has gone by the wayside.
The worst example of such decay
can be found in GE’s biggest division, Power.
There, management so misjudged demand that it is now cutting its 2018
forecast for the delivery of some gas turbines and related technologies by
half! For 2017, group earnings per share
have been cut from $2 to $1.6 and now $1, a stunning miss for a US blue-chip.
Is GE on its way to mediocrity
and even failure? The market seems to
believe so. This perception is driven by
(1) the realization that turning around a company of this size is difficult and
takes times (years most likely, which is longer than most investors can wait
for), and (2) the fact that the new CEO gave a sober but far from inspiring
vision for the future.
Before addressing these two
issues, it is worth considering the scope of this company:
· It
manufactures almost two thirds of the engines that power the world commercial
jets, and
· It
manufactures 30% of the world power generating plants.
Just
imagine what would happen to the world economy if tomorrow these jet engines
and these power plants were suddenly taken off-line…I think this puts GE's global reach, importance and therefore value potential into proper perspective.
Getting
back to the market doubts. Clearly,
turning around Power will take several years, especially if the industry
overcapacity persists. But that doesn’t mean notable progress can’t be achieved within the next 6 months.
Likewise,
the company’s financial reporting can be much improved (and it already is
better), and balance sheet concerns can and must be cleared up (such as long-term
insurance liabilities and pension funding overhangs).
Finally,
it is true that Mr. Flannery’s delivery is less than inspiring. But he does have a good management track
record, and seems determined to improve efficiency and how capital and cash
flows are deployed. Since these are the immediate
priorities, and since he doesn’t have excess funds to do M&As, that should
do for the next 12 to 18 months.
After
that, investors will need to understand how GE plans to keep growing its profit margin. That’s when the “vision thing” becomes
important, and it is too soon to tell whether Mr. Flannery is the man to
deliver and execute on it. But I am confident somebody will.
As
GE is currently in deep crisis, its p/e multiple is bound to look elevated. It is more useful to look at market cap-to-revenues,
or enterprise value-to-revenues[1]. Should it find its way to emulate such peers
as Honeywell in boosting its margins, its stock price would reach $40. Will it, and if so when, that is the
question.
I
for one believe that Mr. Flannery, or failing him a successor, will turn GE
around over the next three to five years.
At a market cap/revenues multiple of 1.25 today it looks cheap. Honeywell is at 2.8.
